 Hello, and welcome to this session. This is Professor Farhad, and this session would look at the translation of foreign currency financial statements. This topic is covered in international accounting, advanced accounting, as well as the CPA exam and the ACC exam. As always, I would like to remind you to connect with me on LinkedIn. If you haven't done so, please subscribe on my YouTube. I have 1,500 plus accounting, auditing, finance, and tax lectures. On my website, I have additional resources if you're interested in practicing, looking at notes, reviews, so on and so forth. I cover many topics. Please check out my website. Also, if you're looking to study with someone, check out studypal.com. They will connect you with someone in your city where you could meet like-minded people. They're in 85 countries and 2,800 cities. So let's start by looking at the two methods of translating foreign currency financial statements. And notice I keep emphasizing the word statement because we are moving from transactions. In the prior session, we looked at specific transactions, specific foreign currency transaction when we had exposure. In this chapter, we're gonna be dealing with actual full financial statements. So it's a totally different concept, okay? What does that mean? Let's assume we are a U.S. company and we are operating in Russia. Well, guess what? At some point, we're gonna have to report all the numbers in U.S. dollar, USD. Therefore, we're gonna translate the whole financial statements into U.S. dollar. Now, we can translate using the temporal method and or the current method. Two methods are available, temporal or for that matter. But the two methods that are available are the temporal method and the current method. Now, in this session specifically, I'm gonna cover, have an overview about the temporal method. In the next session, I would look at the current method. Then I will work an example for each method to illustrate how it works. So we're gonna take this step-by-step starting with this, think of this. It's not an introductory session for this topic. We're gonna be dealing with temporal, but we're gonna be adding little by little. So this is a series of lecture covering the financial statement translation. Now, these terms are not used officially in FASB or in the IASB. So let's start by talking about the temporal method. So what is the big idea? So when we say that the temporal method, what you should be thinking about, the basic objective of the temporal method is to treat as if the foreign subsidiary, that company that's operating for you had actually used the parent currency in conducting your operation. So when you translate, you'll make that assumption. So that's the basic idea. So what does that mean? Let me give you an example. For example, how much would have the company paid for a piece of land? So let's assume a piece of land in Japan cost 12 million Japanese yen. The company wants to buy it and is acquired at the time when one yen equal to 0.1012 New Zealand dollars. So it's a New Zealand branch basically and they're buying a Japanese land in Japan. Well, the new Zealand parent company would send 144,000 New Zealand dollar based on this rate to the Japanese subsidiary to acquire the land. Well, guess what? Then we assume that the land is recorded at the parent company for 144,000 as if the parent company bought it, as if the parent company bought it. So that's the overall, the big idea. Now we're gonna look at the details, okay? Assets and liabilities are reported on the foreign operation balance sheet at historical cost are translated at historical exchange rate to yield an equivalent historical cost in the parent company. Simply put, if you have any assets or liabilities that you report them based on historical cost, well, guess what? You're gonna be using the historical exchange rate. Why? Because they're supposed to be recorded at historical cost. Therefore, you would use the historical cost rate. On the other hand, assets and liabilities reported on foreign operation balance sheet at current, which is market rate, market or future value are translated at the current exchange rate to yield an equivalent value, current value in the parent current currency terms. So simply put, other assets and liabilities they are reported at current rate. So when they are translated to the parent company they are translated at the current rate. Now, those are assets and liabilities. Stockholders' equity are a little bit easier in a sense, but we're gonna have to deal with one particular issue. The stockholders' equity for all translation method, for both translation method are recorded, are translated at historical exchanges. Now bear in mind, we're gonna be discussing retained earnings later. I'll have a whole discussion about retained earnings because retained earnings is little bit more involved. It involves revenues, expenses and dividends. So we have to know how to deal with this. But generally speaking stock, the majority of stockholders' equity with the exception of retained earnings is pretty straightforward. It's exchange at historical rates. So once we use those rules, the application of those rules maintain the underlying valuation method, whether we are using historical cost or current value that's used by the foreign subsidiary in accounting for its assets and liabilities. And don't worry, once we work an example, you will see exactly how this work. This is the overall picture. So let's take a look at some balance sheet account. For example, cash receivable and most liabilities are carried at current or future value under the traditional historical cost model of accounting. Therefore, we're gonna be using the current exchange rate when we translate them. So if you think cash, use the current exchange rate, receivable use the current exchange rate. Most liabilities, we use the current exchange rate. Now, IFRS and GAP, when it comes to inventory, they want you to report the inventory at either lower of cost or not realizable value. Well, the temporal method require inventory to be translated at historical exchange rate when it's carried at cost. So if you carry that cost, if you happen to carry it at cost, you would report it at cost or you'd reported at the current exchange rate when it's carried at net realizable value. So simply put, if you happened to carry your inventory at cost, you would use the cost. If you happen to use the lower of cost or net realizable value, then you would use lower of cost or net realizable value when you translate. Marketable securities are carried at fair value under both IFRS and GAPs. So generally speaking, when we talk about marketable securities, they're reported at current rate or fair value, okay? They are translated into current exchange rate. Current exchange rate is fair value. And that's obviously the case, unless you have a marketable securities that you are holding in total maturity, you are holding at the amortized cost. But generally speaking, those securities will be translated at market rate. Now, what's gonna happen? Sometime we're gonna have a net asset exposure. Sometime we're gonna have a net liabilities exposure, depending if we have more assets or liabilities. So the temporal method generate either a net asset or a net liability balance sheet exposure, depending on whether the asset translated at the current exchange rate are greater than or less than the liabilities translated at the current exchange rate. So simply put, when we translate everything, we're gonna either have a net asset or a net liability. How do we know if we have a net asset or a liability? We take cash plus marketable securities plus receivable plus inventory when carried at net realizable value. And if they are greater than liabilities, we have a net asset exposure. And the other side is true. If we take cash, marketable securities, receivable inventory, and if they are less than liabilities, we have a net liability exposure. We have a net liability exposure. Now, bear in mind because liabilities current and long-term usually are greater than assets translated at the current exchange rate. And that liability balance sheet exposure generally exists when the temporal method is used. And we'll see later on why that's the case. What could complicate things under the temporal method? Or what are the issues that we have to be on the lookout when it comes to the temporal method? Under the temporal method, it's necessary to keep record of exchange rate that exists when inventory, prepaid, property, plant and equipment and intangibles are acquired because they are carried at historical cost. So we have to kind of make sure we know what is our historical cost when those assets are acquired, okay? Now, we're gonna see later in the other method, keeping track of historical cost under the current rate method, which we did not discuss yet. It's not, we don't have to worry about this. So translating these assets at historical cost makes application of the temporal method more complicated. Under the current method, we don't have to worry about the historical cost. And we'll see later on the current rate method. Let's talk now about the accounts that are on the income statement. How do we translate them? Now, here's how you have to translate them. Income statement item are translated at the exchange rate that exists when revenue or the gain is generated or when the expense or the loss is incurred. So you have to do it when it happens. Now think about it, let's assume McDonald's. McDonald's sell burgers all day long in France, okay? And guess what? The euro is changing constantly in France throughout the day. So are they gonna keep track of every transaction? It's not practical. Therefore, you cannot keep track of the fluctuation. So what you do with most item and assumption can be made that revenue and expenses are incurred evenly. Because think about it, you're constantly running the making sales. 11 o'clock, you made a sale. 1101, you made another sale. 1102, you made another sale. And guess what? As you're making those sales in euros, the euro versus the dollar is changing. So McDonald or any company, they cannot keep track of this transaction. So what you do is you would assume that the transaction are incurred evenly throughout the period and you would use an average for the period exchange rate. So you'd use an average rate for revenues and expenses, for revenues and expenses. However, for items such as cost of goods sold, remember, cost of goods sold is part of inventory. Depreciation, which is part of property, plant and equipment. And amortization, which is part of intangibles, those are carried at historical cost. Because the related asset to them is reported at historical cost. Inventory, if it's reported at historical cost, well, guess what? Cost of goods sold should be historical cost. Depreciation, historical cost, because when you bought the property, plant and equipment, so if it's on the balance sheet, historical cost, the related expense to it has to be on the historical cost. So you have to be careful when it comes to expenses. Certain expenses are treated differently. Because these assets are translated at historical exchanges, the related asset to them must be also reported at historical exchanges. And obviously you can see this, not obviously, hopefully you can see this, that to be consistent. You cannot report an asset at historical cost, and it's related expense at current value. And hopefully this is starting to make sense here. Also, we have to be careful. We have revenues and expenses, but we also have gains and losses. Remember, gains and losses are peripheral. Those are not common transaction. Those that occur on a specific date are translated at the exchange rate at that specific date. So simply put, for revenues, sorry, not revenues, for gains and losses, gain and losses, they don't happen on a regular basis. Going back to McDonald's, I told you, they're gonna be selling burgers all day long, but they might sell an old warehouse that they own or an old piece of land, okay? Well, if that's the case, they might incur again or a loss. Now, because this is a transaction that can be specified, then guess what? We're gonna be using the exchange rate on that date because we can pinpoint that date and it's easy to keep track of it, okay? Now, let's take a look at a summary. So this is the current method, which is I am hiding for now. So simply put, this is an overview. This is an overview of things. Cash and receivable is when it's translated at current, marketable securities generally speaking at current, unless you have something held to maturity. Inventory reported at net realizable value, it will be exchange at current. Inventory at cost will be translated at cost. Prepaid, property, tenant, equipment and intangibles, those are reported at historical and also any expenses that stem from them. For example, if you have prepaid, you're gonna guess what? The prepaid eventually becomes expenses. Well, you have to be careful. If it's coming from a historical cost translation, then the expense would also be historical cost as well. Now, current liabilities, current liabilities are reported at current, the third income historical long-term debt are at current, current rate, okay? Now, capital stock, additional paid in capital, dividend, retained earnings. We say all of those are historical rate. We will deal with retained earnings in a separate recording tell you when you translate this. Now revenues on average, oops, sorry, sorry. Revenues is translated on average using the average rate. Most expenses average unless those expenses are related to those assets. Cost of goods sold historical because if we're carrying the, we'll look at cost of goods sold later in a separate recording, depreciation and amortization. We'll have a separate recording for those three and a separate recording for retained earnings just to make sure we, you know how, because this is where the complication comes into. So let's take a look at the overall idea between the financial transactions that we talked about in the prior chapter and the financial translation. So remember in the prior chapter, we looked at what we called a transaction. We looked at specific foreign currency transaction. In this chapter, we are dealing with translation, translation of the whole financial statement. Now remember transaction, they go through the cash inflow and outflow. They go through the cash inflow and outflow. Foreign currency adjustments are a little bit different, okay? The foreign currency, the foreign currency, sorry, the translation adjustment could be realized at again or a loss under certain circumstances. What are those certain circumstances, okay? Well, the foreign subsidiary collect all the receivable in cash then uses it to pay off all the liabilities. And so simply put, they no longer have a receivable, they collected all the cash and they paid off all their liabilities. And if there's any net asset balance sheet exposure, which is now it's all cash, the access cash over liabilities is sent to the parent company where it's converted into the parent company currency or if there's a net liability, the parent company would intervene and will pay off the liability. Will pay off the liability. Well, that doesn't usually happen, okay? So when you do financial statements translation, that doesn't usually happen. It's simply put, you don't collect all your receivable, you cannot force your client to send all the money then you're gonna take the money, translate the money and send it to your parent company or if you have a net liability, the parent company is gonna come in and pay the liability. So really it doesn't go, eventually little by little, the foreign currency translation will go through the inflow of outflow, inflow and outflow of cash, but not the whole thing because you are preparing translation, translation for everything, for the whole financial statements. So it's a little bit different than foreign currency transaction because foreign currency transaction are eventually settled, are eventually settled maybe six month, nine month, no less than a year they are settled there. Either you have to pay the foreign currency, you have to pay to, you receive the money or you have to pay in foreign currency. So this is the overall idea. In the next session where I would do, I would look at the current rate method, then we would look at the retained earnings step by step and we'll build on this. So keep, stay motivated and keep up with your lessons and you should be fine. If you have any questions, email me. 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